International | 1:35 PM
Michael Howell, founder and managing director of CrossBorder Capital, chatted with FNArena from London about global liquidity, its impact on asset markets including equities, gold, bonds and commodities.
Michael also expanded where liquidity is in the cycle versus the longer-term trend.
Below is a transcript of the interview which is available at
and/or
https://www.youtube.com/watch?v=KsCf0E0m8OU
The interview was conducted on 25 September 2024 and the video was released two days later.
Danielle Ecuyer: Michael, could you provide some background for listeners?
Michael Howell: My history goes back to when I worked for Salomon Brothers, the US investment bank, in the second half of the 1980s. Salomon Brothers, for those that don’t remember, was probably the pre-eminent trading firm in bond markets worldwide. It traded government bonds around the world and was big in forex with an understanding of what was going on.
Salomon’s devoted a lot of time to research, including researching ideas that we probably take for granted now in financial markets; many often emanated out of the Salomon Brothers research team. One of the big things they used to focus on through the office of Henry Kaufman, the head of research, was flow of funds analysis for the US economy.
In other words, trying to understand the flows of money going into financial markets, and how that was reflected in terms of rising or falling asset prices, changing interest rates, moving currencies, etc. At the time it was very much a US centric view.
By the late 1980s, the world was becoming more and more global, so I just extended the analysis to the international arena, and started to look more and more at cross border flows, what international central banks were doing and how that affected global financial markets. And I suppose, hence our name CrossBorder Capital was formed.
Danielle: Can you flesh out a little bit more what your parameters are for global liquidity? What sort of things do you include in your measures?
Michael: Let me go further and say that if you look at the global picture, the total amount of liquidity winging its way around the world is about US$175trn, which is about one- and three-quarter times, or one and two thirds’ times bigger than world GDP.
So, it’s certainly a big pool of cash and it’s very important to understand in terms of what we mean by liquidity. I think you’ve got generally two definitions out there. One is what traders or investors tend to think of as market liquidity, in other words, the market depth they’ve got when they’re trading or investing. Can I buy 100,000 shares in BHP, around the current price spread and in market size? That is one definition of liquidity, that’s market liquidity.
That’s not what we mean, although it tends to be a derivative, and it follows from the concept we monitor, which is funding liquidity. And what that is really saying is: is there the credit or savings in the system that will allow this transaction to take place?
Funding liquidity is really measuring all the credit and all the cash savings that exist in a particular market. We aggregate it, because liquidity moves around, it’s fungible. It moves from country to country, particularly in a world of floating exchange rates. And therefore, global liquidity is the key concept to understand.
This is all the credit and cash savings worldwide, the amount that is passing through world financial markets. We can look at that through the lens of what central banks are doing; we can look at it through the lens of what private banks are doing, both shadow banks and a high number of high street banks, and we can look at it in terms of cross border flows, all those factors. All those dimensions we include in our measure of global liquidity.
Danielle: Can you comment on the concept of financial abundance?
Michael: Okay, very good point. Danielle, I think the first thing to say is liquidity is cyclical, and the bottom of the last cycle was around October of 2022, and we’ve been seeing rising liquidity in the global economy, or at least rising liquidity in financial markets passing through financial markets, ever since.
That’s why world asset prices are going up. For those that have noticed, we’ve had a two-year bull market pretty much in risk assets. And the reason for that is not necessarily because the global real economy is generating huge amounts of profits and not really because interest rates have been coming down.
It’s much more because the flow of liquidity has been going up. If you want to understand financial markets and how financial markets move, you’ve got to look at this concept, embrace this concept of global liquidity, because it’s key. This explains why Wall Street is soaring. This explains why gold is at an all-time high. All these asset prices are getting a bid because of rising liquidity.
Now, as I said, global liquidity is cyclical, and we’ve got to try and remember that it’s not always abundant. There will be times where there will be a scarcity of liquidity, and that’s really important. The way to sort of understand the whole process is to think, first, in terms of debt. We’ve got massive amounts of debt in the world economy, something like US$350trn of debt.
The point about debt is that debt doesn’t really go away. You know, spoiler alert, debt is never repaid. But debt under a contract of issuing debt, that debt should be repaid. And if I borrow, let’s say, US$100m for a five-year term, I’ve got to repay that US$100m in five years. And that may be a burden.
If you start to think about this US$350trn debt worldwide, which has an average life of about five years, that means, by simple math, every year, on average, the world financial system must refinance something like US$70trn of debt on top of what they’re getting in new finance as well.
The reason for making that point is this is often lost on a lot of commentators, simply because economic textbooks tell you the financial sector is all about raising new capital for investment. Equally, that investment drives the business cycle, and that’s often why economists tend to refer to nine-to-10-year cycles, because that’s really the cycle, or the period of capital investment, the depreciation and reinvestment of capital.
Unfortunately, that world was left behind many, many, many decades ago. The world doesn’t work like that anymore. If it did work like that, interest rates may well be important. They’re not in the current world, and there’s this great dance we go through every time the Federal Reserve coughs about interest rates, but it’s largely irrelevant.
What really matters is the amount of liquidity that central banks create and inject in their systems. The reason for that comes back to the whole ethos of understanding refinancing in markets. If you’ve got US$70trn to refinance, you need balance sheet capacity to do that, and balance sheet capacity in the financial sector is all about liquidity. If there is insufficient balance sheet capacity, and insufficient global liquidity in the system, you cannot refinance your debt.
If you can’t refinance your debt, you get a debt refinancing crisis. Every financial crisis you can think of over the last few decades has been a debt refinancing crisis going back to 2008, going back prior to the Asian financial crisis, thinking back to the US repo crisis in 2019; they’ve all been about debt refinancing problems, and therefore you need to keep a level of liquidity up to avoid those crises.
That’s the job of central banks. Largely, if the private sector fails, such as the shadow banks in 2008, then what we’ve got to get is central banks coming in. Will there be a financial crisis in the future? Absolutely there will be. Because basically, debt grows exponentially and liquidity is cyclical, and sometimes those two lines don’t match, and when they don’t match, you get a financial crisis. And that’s something we can think about, not immediately, but maybe a couple of years hence.
Danielle: Are central banks more efficient at pre-empting financial crises?
Michael: I think the answer is, they are, until they’re not. And the great problem is the financial sector innovates, and the private sector always wants to create more and more credit, more and more liquidity, if you like, at least when left to its own devices, and central banks and policymakers always like to rein in the expansion of private sector credit vehicles.
They’re always sort of increasing regulation or trying to stop it, unfortunately or fortunately, depending which way you look at it, the private sector is obviously a lot more alert than the policymakers, the regulators, and they tend to be a couple of steps ahead.
In other words, the financial system, in terms of liquidity provision, tends to be quite elastic, but then as regulations start to impinge and as central bank policy starts to tighten, you then see the private sector lagging seriously behind what levels of liquidity are necessary to refinance debt.
That’s why you tend to get a financial crisis, and that comes back to the sort of understanding why liquidity is generally cyclical.
Another thing one might throw into that: if you get a very strong real economy, money can’t be in two places at once. If it’s in the real economy, financing economic growth, it’s not in financial markets helping debt refinancing, and that’s another reason that you can get a crisis. All these things matter in the long run, but central banks certainly have improved their game enormously since 2007, that is without question.
Danielle: Where are we currently in the cycle?
Michael: I think it’s important this time to actually start to think not just of the cycle in global liquidity, but also try and envision a trend that’s going on as well. Because one of the things that has happened, certainly in the wake of the 2008 financial crisis, and more particularly following the covid crisis, is the governments worldwide have started to increase their outlays and their spending dramatically.
For example, the US government’s outlays are four times bigger today than they were ahead of covid. There’s an enormous increase in outlays, whereas tax rates are not really going up at the same pace. What you’ve got is very, very large primary deficits before interest payments in most of the western world.
The scale of that is unprecedented. Once you start to add in interest costs as well on the debt they’ve got, you start to see government deficits growing at six to eight percent per annum. We were used to, historically, seeing maybe one or two percent occasionally over the years, but nothing like a sustained or embedded six to eight percent. The question is: how do they fund that?
Increasingly, they’re turning to financial markets to fund that, and they can’t keep using the long end of the market. Selling bonds to institutions pushes up long term interest rates, and that compounds the whole interest bill. What they must do is to go to the front end, the short end of the market, and effectively to use another expression, print money. And that is what is increasingly happening. If you look at the US, the US currently is funding the deficit 75% with monetisation.
They’re basically monetising the US deficit. Milton Friedman, long departed this earth, would be turning in his grave if he started to see what was going on right now. That’s the reason that you’ve got gold at all-time highs. There is monetising going on. The US is not the only party doing this, everyone else is beginning to turn in that direction.
That’s why I think it’s important to think about the trend. Because if you start to look at extrapolations of government spending and government deficits by the IMF in every country, you start to see rising debt to GDP ratios to eye-watering, really large levels.
The US debt to GDP is about 100% or so and likely to test 200% by 2050. These are astronomical demands on financial markets. That’s why the gold price is going up. That is why the gold price is going to go up even more.
If you’re compounding at a growth rate between eight and ten percent, you are doubling the stock of debt within 10 years. That means not only the stock of debt is going up, but also the value of gold is going up, or the value of the amount of liquidity in the system is going up, all these things are moving pari passu.
It’s not just the cycle, even though I emphasise the cycle, you’ve got this time around to think about the trend as well. Therefore, start to think of money, inflation hedges in portfolios, and start to think gold or Bitcoin, or starting to diversify into commodity markets,
Danielle: Can you explain how central banks are monetising the debt?
Michael: At the risk of getting caught in the weeds, if a long-term institution or a private individual buys a government bond that is just coming out of existing savings. So, there’s nothing untoward about that. That’s normal funding. If the government issues too much debt to that body of investors, then interest rates are likely to go up, and that’s a risk. If they start to issue to banks, and banks buy the debt, the banks’ balance sheets will expand.
As banks balance sheets expand, that is increasing money supply. For example, if a government employee gets a pay increase and they deposit the increased wages in their bank account, the bank has to find an asset that will broadly match that deposit, so they will go for a government bond, and particularly a short, dated government bond, because that’s pretty much matching the type of duration or the type of risk they’re taking over the deposit.
So, the balance sheet, both liabilities and assets rise, and as bank deposits increase, and it’s funded by raising government bonds, that is an increase in money supply, and it’s a monetisation, and that’s exactly what the US is doing.
If you look at what Janet Yellen at the Treasury has overseen in the last two years, there’s been something like a one and a quarter year drop in the average maturity of bonds that are being offered in US auctions. That may not sound like a lot, but in fixed income speak that’s an enormous change. They’re basically skewing the calendar towards very short-dated bonds, and they’re encouraging by doing that, for banks to buy the stuff.
If you think of treasury bills, that’s not an instrument that you know is sold on the high street. It’s not something that household investors tend to hold. It’s what institutions, and particularly credit providers like banks, hold. So, what you’re looking at is a significant increase. Almost a quarter of all US government debt is now in treasury bills with very short term, less than a year, in maturity.
Are governments going to reverse track and start to fund at the long end? They will find it difficult to do that without raising interest rates, and that would compound the interest bill, so they don’t. They basically kick the can down the road, and they fund at the short end.
Danielle: Would the US default on its debt?
Michael: The idea of the US defaulting is fanciful. I mean, that’s just nonsense. It’s incapable of doing that because we all use dollars. The whole international financial system uses dollars. America can always pay its debts by printing money.
The issue is not so much a binary will it default or not? It is much more about what is the faith or the ultimate value of the US Dollar as a store of value. The fact is if they’re printing so many dollars, although they may force us to hold those dollars and therefore avoid default, the value of the dollar goes down. That’s not against other paper units. That’s a fake narrative as well.
If I’m looking at the USD versus the Yen, or looking at the USD versus the Aussie dollar, you don’t really see the movement that much. These things are basically depreciating together. It’s gold that you really ought to look at, which is an independent benchmark, or even Bitcoin; dare I say that seems to be moving a little bit like digital gold. What you’ve got to look at is alternative benchmarks to try and gauge the devaluation of paper money.
The US may well be the cleanest shirt in the laundry here compared to other countries, The Eurozone, where you’re looking at is a very ugly situation. When it comes to demographics, it’s the wealth, the cost of welfare states, that is really driving these governments towards bankruptcy, and that’s the problem we’ve got. The tax base is not increasing. Outlays are zooming higher. Europe, as an example, must take on more and more defence spending, and it just can’t afford to do it.
How do they square the circle? They’re going to have to monetise in some form. The US has already got that bug. You know the Bank of Japan owns most of its government debt market. This is why the gold market is going up. Other countries outside of the Western orbit, China, Russia, Iran, etc, are basically using gold now as as one of their main reserves.
It’s not the question of whether the US is going to default on its debt, or the US dollar is suddenly going to worthless. That won’t happen. The fact is the US still has the biggest financial markets in the world. If you’ve got a country like China that is earning an enormous trade surplus, there’s only really one place for them to put their surplus, and that’s in US financial assets. There’s no other game in town.
At the margin, they’re starting to shift more of their reserves into hard assets like gold, and that is pushing the gold price higher.
Danielle: What asset classes do you like and what are your thoughts on the latest China stimulus?
Michael: I think everyone’s right to look at China and to see China as one of the major problems out there for the world economy or policymakers to tackle. Having looked at several of the comments in the media in the last 24 hours, a lot of what I can see is just rubbish. People are focusing on ridiculous things, like there’s a 20-basis point cut in rates, or whatever it may be, or they’re giving support to the housing market, or putting a few extra dollars into the stock market.
What we’ve got is a situation where, structurally, the model of what you may call red capitalism, which is China’s recipe for success, is no longer working. The reason it’s no longer working is it really needed the West to accommodate it. And the West is now saying, hang on, we’re not going to do this anymore. We don’t want to open our markets to cheap Chinese products and destroy jobs.
You can see that emanating worldwide, but particularly coming from the US, and certainly coming out of the lips of the mouth of Trump, who really started all this.
But I think it’s a general movement. People are very concerned about China dumping goods, and that won’t happen in the future. So, China’s got to rethink its whole economic system. It needs to enfranchise the consumer; it needs to get consumer spending higher. It needs to find other avenues of growth.
Ultimately, what this is really telling us is that China is over-producing products, just look at the market for electric cars or solar panels or whatever. They’re producing every year more than the world can ever consume. The only way China can square this circle is by letting its real exchange rate collapse. Think of it as the nominal Yuan multiplied by some price index put through high street prices or asset prices.
What China is doing right now is not letting its real exchange rate collapse. It’s holding the nominal Yuan up at high levels. The yuan is now almost at a year to date high as we speak, and they’re taking all the punishment on the chin of lower prices. Consequently, the real exchange rates are adjusting lower by prices falling, particularly asset prices, and that simply cannot go on.
Ultimately, China’s either got to stop production and print lots and lots of money, and hope it gets the exchange rate down a tad and starts to get asset prices and high street prices up. If China is serious, we’ve got to look over the next few months and see whether there is a big monetary expansion. You simply cannot judge that on one day or 24 hours news. You’ve got to look at what the People’s Bank is doing over a sustained period, and that’s what we intend to do.
We suspect the Chinese, not being foolish, are going to start stimulating their economy. Therefore, you’ve got to look for more, much, much bigger liquidity stimulus, maybe over a three-to-six-month period. That will involve not CNY1trn, but several trillions of money dumped into their financial markets.
If that is the case, and we suspect it could be, you’re going to see commodity prices worldwide lifting off very substantially again. You’ll also see the price of gold rocketing and making even higher all-time highs. So that’s the recipe, and China is key to understanding it.
Danielle: Does monetisation feed into high street inflation?
Michael: Absolutely, it is a dominant risk. I would disagree with the fact US inflation is currently 2% which is what the Federal Reserve tells us. It’s considerably higher than that. It’s more likely in the three to four percent range, underlying US inflation. But the figures are being distorted by what the Treasury and the Federal Reserve are doing.
We tend to think of high street inflation as being a cocktail, or a hybrid of different inputs. Monetary devaluation, or devaluation of paper money, which we’ve been speaking about, is one of those ingredients. Another could be things like oil prices. Another could be technology. Another could be cheap Chinese goods. All these factors tend to be inputs into high street prices.
I’m sure people around the world will attest or back me up, but if you look at my personal inflation rate it certainly isn’t two percent; it’s a lot higher than that. So high street inflation is probably wrongly quoted. It’s a higher level than the two percent that is sort of appreciated worldwide.
Among the factors that have held inflation down are things like increased technology, AI, cheap Chinese goods, the fact oil prices are still significantly below their 2008 high. Monetary inflation may well have been substantial in the last 20 years, vis-a-vis gold, asset prices, but it hasn’t fed through to the High Street, because you’ve had these offsetting factors.
If you roll forward for the next decade or two, you’ve likely got liquidity expanding by an eight to ten percent annual rate and you may not get these offsets in the High Street, so quite likely you’re going to see monetary inflation, in other words, devaluation of paper money spilling over to a much greater degree in terms of consumer prices. Therefore, I would say the starting point has got to be not two to three percent, but more likely three to four percent, and possibly a bit higher.
Danielle: What assets do you like?
Michael: It comes back to looking at the cycle and differentiating that from the trend. I think, in terms of the trend, we’re in a world of much greater monetary inflation. And that’s insane. Monetary inflation is here.
It’s going to get a lot worse. You need protection against monetary inflation in investment portfolios. The 60:40 mix of equities, 60% in equities and 40% in bonds, which is traditional among advisors, you can throw that out of the window because it doesn’t work anymore. In a monetary inflation you need more diversification into dedicated monetary inflation hedges. Take that 40%, which is traditionally in fixed income, and start to dice it up into other areas.
You could put 10% into cash, 10% into other real assets, maybe like commodities or more dedicated inflation hedges. You probably want to put some in fixed income, but I would say you want to be in TIPS. In other words: inflation protected securities. Even holding money in cash at the short end of the market, you can still get decent returns.
Start to look at prime residential real estate, because that tends to do well in monetary inflation. I think all these dimensions are better and will give you better returns than conventional bonds.
Bond markets are yielding a return of something in the order of 4% to 5% worldwide, whereas we’re looking at monetary inflation rates of near eight to 10%. That’s telling you bonds are not really keeping pace.
Equities will keep pace, certainly high-quality equities, and certainly, equities in things like the technology space or maybe commodity related; those are the sort of things that should keep pace in this environment. But you’ve got to move away from a 60:40 portfolio and start thinking more about diversifying or chopping out that 40%.
In terms of the cycle, the liquidity cycle bottomed in October of 2022, and we’ve been saying pretty much ever since that point it’s likely to peak out in late 2025. So you’re looking at something like a three-year bull market.
We’re probably two years through that already, so we’ve got some way to go, but a lot of the gains have already been taken. You will make money by investing in risk assets over the next 12 months, likely, but a lot of the gains are behind us.
The adage still applies: bull markets always climb a wall of worry. How many advisors have been telling you the last two years not to invest in these markets? I should think an awful lot.
It pays to be a contrarian: buy at the bottom, right at the bottom of the global liquidity cycle, and sell towards the top. We’re not at the top yet, but we will be in 12 months.
Danielle: Australian premium quality residential property has been in high demand, is this a sign of monetary hedging?
Michael: 100%. These are dedicated monetary inflation hedges. They tend to historically match rates of monetary inflation. This is evidence this is happening, as is the gold market.
If you look at this politically or geopolitically, we’re not creating what the socialists call industrial proletariat. We’re creating a financial proletariat, because those people that don’t have assets are really screwed in this world.
You’ve got to have assets to try and protect yourself against monetary inflation. And if the world, as we characterise it, is going to feature higher High Street inflation as well, then the poorer elements of society who must spend most of their remuneration on food or goods, are going to get absolutely squeezed in the next decade or so, and so you’re going to get this huge rift in society. We’ve already seeing it, but you ain’t seen nothing yet.
Danielle: Michael how can people access your research?
Michael: There are basically three channels that we publish through. One is a substack called Capital Wars, where we provide data and narrative about what’s going on. We do the occasional tweets on Twitter (X) with the handle @crossbordercap.
There’s a book I wrote about five years ago which is called Capital Wars, which details all this stuff about global liquidity and why it’s relevant and how we measure etc, published by Palgrave Macmillan.
The fourth area is looking at our institutional research service, which is providing a lot of data to quant funds or providing analysis for traditional institution investors. That’s available on www crossbordercapital.com.
You can find Michael Howell on X @crossbordercap: https://x.com/crossbordercap Substack at Capital Wars: https://capitalwars.substack.com/
Website: https://crossbordercapital.com/
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